Double Top and Double Bottom

You may have come across these two well-known terms: the double tops, and double bottoms. They are classified as some of the most common price reversal patterns in the currency market. Not surprisingly, the familiar M- or W-shaped patterns appear regularly on anything from 15-minute charts to weekly ones.

As a rule of thumb, the higher the timeframe means the more accurate the reversal will be.

In this lesson, we will look at how you can identify these patterns and use them to make profitable trades in forex.

How to identify Double Tops

The basic double top price pattern has three stages:

1. The price makes a short-term swing high

2. This is followed by a slight retracement

3. Price finally makes another move on the swing highs, only to be rejected once more as the reversal pattern completes itself.

Why do these patterns occur constantly?

The basic formation of these patterns is due to the fact that price has a memory. A bit ambiguous but when you think about it, price tends to obey prior points of resistance or support. Thus traders, knowing those support and resistance levels well in advance will begin to aggressively buy or sell ahead of these levels, with belief that since these prices recently held, they will hold once again.

This method is often quite profitable but to properly trade a double top, you will first need to determine what constitutes a proper price retracement. Otherwise, the price pattern may look like a simple consolidation range, which would greatly lower the probability of success in the trade.

A simple yet effective way to calculate a retracement in a double top is to use Fibonacci retracement levels. The retrace segment should be at least 38.2% of the prior move in order to be considered valid.

Let us have a look at the screenshot below:

Using the Fib numbers applied to the previous top, we can see that the formation, in case a double top is formed would be valid as it retraced all the way down to the 61.8 region. We can see the price meets heavy resistance at the 61.8 level and heads up again to retest the previous high. Market loses momentum at that point and nearly reaches the previous top when bearish candlestick marked 1 is formed.

This bearish candlestick formation is confirmation that reversal is on its way. Enter as soon as next candlestick opens (marked 2) with stop loss previous high. Profit taking depends totally on you. A good way of managing this trade is to take half the profit at nearest support level while bringing the stop loss to break even and letting the remaining lot run for bigger profit.

The opposite rules apply to a double bottom. Again, be aware that the higher the time frame the more accurate the signal. Easy ways to look for those formations are to keep an eye open for an M- and W- formation.

Happy trading.

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